Portugal's president has ordered a legal inquiry into the country’s austerity
policies and threatened a showdown with creditors over the draconian terms
of its EU-IMF bail-out.

President Anibal Cavaco Silva called for urgent action to halt the “recessionary spiral”, warning Europe’s leaders that the current course had become “socially unsustainable”.

In a speech to the nation, he said Portugal would “honour its international obligations”, but in the same breath called for a tough line with the European Union-International Monetary Fund Troika over the pace of fiscal tightening under Portugal’s €78bn (£63bn) loan package. “We have arguments, and we should use them firmly,” he said.

“Fiscal austerity is leading to declining output and lower tax revenue. We must stop this vicious circle,” he said, cautioning the Troika that there would be no way out of the crisis until policy was set in the interests of the “Portuguese people” as well as foreign creditors.

His sombre speech was a reminder that Europe’s crisis is far from over.

Portugal’s jobless rate has risen from 13.7pc to 16.3pc over the past year, reaching 39pc for youth, even before the full impact of austerity hits.

In a stinging rebuke to the country’s free market premier, Pedro Passos Coelho, the president asked the constitutional court to rule on the legality of tax rises that come into force this January as well as on further moves to dismantle the welfare state in the 2013 budget.

“There are well-founded doubts over whether the distribution of sacrifice is just,” he said. Mr Cavaco Silva’s broadside against ministers from his own centre-right Social Democrat party leaves the government starkly isolated, and increasingly in danger of losing its authority.

Popular anger is building over the over the Troika’s fiscal shock therapy, which will push up average income tax rates by 3.4 percentage points and bring in a plethora of surcharges and fees. It aims to cut the budget deficit to 4.5pc this year, largely through tax rises.

Markets have so far brushed off worries that the country risks a Grecian vortex as austerity bites in earnest. Yields on 10-year Portuguese bonds plummeted 30 basis points to 6.76pc on Wednesday as relief over America’s budget deal fuelled optimism across the world.

“Investors are willing to give Portugal the benefit of the doubt right now, but the country still hangs in the balance,” said David Owen from Jefferies Fixed Income.

“Our concern is that the fundamental economic situation is still getting worse. The European Central Bank’s policy is still too tight. They need to do quantitative easing and cut overnight rates below zero,” he said.

Markit’s manufacturing index for the eurozone fell further below the contraction line in December to 46.1, led by a steep drop in new orders – even in Germany. “The region’s recession looks likely to have deepened, possibly quite significantly,” said Markit’s Chris Williamson.

Portugal has taken its medicine with stoicism until now, winning praise from the EU leaders for sticking to its bail-out terms. But Troika officials fear that “social cohesion” is fraying as the slump deepens. The country saw the biggest street protest this autumn since the end of the Salazar dictatorship.

The Organisation for Economic Co-operation and Development expects the economy to contract by 1.8pc this year after 3.1pc last year, pushing public debt to 133pc of GDP. Yet forecasts vary widely. Citigroup predicts a fall of 4.6pc next year. Such damage would play havoc with debt dynamics and set off the sort of snowball effect seen in Greece.

Mr Passos Coelho is selling off state assets at breakneck speed to plug gaps, clinching a €3bn deal before Christmas with the French group Vinci for Portugal’s ANA airport network.

It follows €3.3bn privatisation of energy assets, including a 21pc share of the power utility EDP and 40pc of the gas transporter REN. The Viana do Castelo docks and public television RTP are also on the block. Lisbon has postponed the sale of the national airline TAP after receiving just one offer for €340m.